Geopolitical risk prompts family offices to diversify investments

Family offices seek portfolio diversification to manage risks, despite increased equity holdings.

As wealthy families are increasingly concerned about geopolitics, inflation and potential recession, portfolio diversification is becoming essential. However, equities are still a key holding, with the tech giants dominating portfolios.

Nancy Curtin, global chief investment officer at AlTi Tiedemann Global, a wealth and asset manager that manages or advises more than $70bn in combined assets, says that the firm offers three 'building blocks', called stability, diversified and growth, and every client has exposure to all three of them.

In the stability block, aimed at capital preservation, the firm favours municipal bonds for US taxable clients "because it's a pretty, tax-efficient way to have a good amount of liquidity”, explains Ms Curtin.

Municipal bonds tend to be very liquid instruments and are exempt from federal tax but can also be exempt from state and local taxes. June was municipal bonds' second-strongest month in 20 years, bringing performance back to -0.02 per cent for the quarter, after negative returns in April and May.

Regardless of the client's strategic asset allocation, the firm has been underweight stability, because it finds more “attractive returns” in diversification. The US’s future deficit and debt problems also pose problems.

Within the diversification block, private credit holds considerable value, as “you can get a significant yield pickup”, says Ms Curtin.

The size of the private credit market at the start of 2024 was around $1.5tn and is estimated to grow to $2.8tn by 2028, according Morgan Stanley.

Ms Curtin also sees many positive trends in construction, an industry that is much easier to access via private than public markets, she claims.

Infrastructure boom

“In the States, you have the Chips Act and the Inflation Reduction Act, both of which are incentivising investment spend, either on the part of the government or tax credits to companies to build infrastructure,” she explains. “Secondly, you've got the onshoring of production, so companies are bringing production back home again."

Digital transformation also plays a role in the infrastructure boom, she believes.

Amid rising geopolitical tensions, gold has become a favourable asset for family offices. “We think it's a really great diversifier for client portfolios. It's super liquid and has done a very nice job this year,” she says.

On the growth front, a significant portion is allocated to passive investments, says Ms Curtin, allowing clients to benefit from the success of large companies like the Magnificent Seven (Apple, Amazon, Alphabet (Google), Microsoft, Meta, Tesla and Nvidia). Similarly, private equity is growing in popularity.

Technology allocation

According to Citi Private Bank’s second quarter family office investment report, family offices continue to allocate more to equities and hedge funds, with a modest revival of interest in fixed income.

“There's a lot of work out there that says election years in the US tend to be positive for equity markets,” says Hannes Hofmann, head of global family office at Citi Private Bank.

“What you see is that a lot of the additions to equity that have happened have actually happened in US large caps, which is mostly the technology stocks. Broadly speaking, the changes we've seen were ‘risk on’, with the view that technology would do very well,” he adds.

Family offices are in a period of reevaluating stock trading, says Mr Hofmann. “In Europe, we've seen a rotation out of some of the US large-cap equities and into more international equities,” he states. “But broadly speaking, we're still seeing the majority of the allocation to the US, large-cap with a significant technology allocation."

Citi’s investment report also shows signs of more allocations to hedge funds. According to Mr Hofmann, this indicates that family offices are aware of risks in the market.

Geopolitical risk

“They want to find ways to build strategies that will work when geopolitical risks happen or if technology starts to sell off,” he says.

Mr Hofmann has also noticed that family offices are increasingly asking about quantitative investment strategies.

These derivative overlays can be put on a portfolio to effectively make money in different market scenarios. “Family offices are looking for ways to manage the portfolio risk while they continue to be invested in equities.”

Family offices will also be closely watching the outcome of the US presidential elections. AlTi Tiedemann Global’s Ms Curtin says investors should not be too overworked.

“Candidates make a lot of proclamations as they're campaigning, they're going to do this, and they're going to do that, and this is what they stand for. What actually gets through Congress and what actually gets done is a very different scenario,” she says.

Despite this, she does not see any candidate wanting to pursue fiscal prudence. “The deficit situation is very large in the States. The national debt continues to increase, and Trump's tax cuts are set to expire."

This, of course, is worrying news for the US. A wide deficit and increased debt levels could hinder its ability to react to future economic downturns, which could mean higher interest rates, instability in the bond market, and reduced investor confidence. Higher bond yields might influence investors to divert money away from stocks.